Taxes and Life Transitions: Career Changes
Career changes, whether you’re starting a new one or facing a job loss, will impact your taxes. After all, the bulk of your tax liability very likely comes from earned income, and when that increases (or decreases), your taxes will be significantly affected.
When you are starting your career or changing jobs, there are a number of documents and expenses that need your attention. First, you’ll need to complete or update your W-4 form, so your employer withholds the correct amount of federal income tax. However, before you starting filling out that form, you’ll need to know what your personal allowances and deductions may be; otherwise, you may have too much or too little withheld from each paycheck.
To start, you’ll claim yourself (provided no one else claims you as a dependent for tax purposes). You can also claim your spouse and the number of dependents you will claim on your tax return. Be careful in claiming your spouse on your W-4 if he or she is also employed full time, or you may end up having too little tax withheld and a tax bill due in April. Additionally, if you typically itemize deductions on your return or claim certain credits or income adjustments, you should take these into account when completing your W-4 form. Check out the IRS Withholding Calculator to help make the process a little easier.
If you relocate for your new career, you may be able to deduct moving expenses. In order to do so, you must meet three requirements: timing of your move, the distance test, and the time test. For more details on these requirements and whether or not you are eligible for this deduction, please see Deducting Moving Expenses.
There are also some job-related deductions that you may be able to claim, and these are not limited to those who are self-employed or own their own businesses. You can deduct unreimbursed employee expenses that are required for you to complete your job function as long as the IRS considers them to be “ordinary and necessary.” Some examples include: legal fees; licenses; occupational taxes; dues to professional groups, unions, or trade groups; required education; work clothes or uniforms; subscriptions; and medical exams required by your employer. Mileage is also deductible, but generally excludes your commute to and from work. If you work multiple jobs or are required to drive for your position (e.g. sales rep driving to a client’s office), this mileage can be deducted.
Keep in mind that these items are only deductible if you do not receive reimbursement from your employer, and you must itemize your deductions in order to claim these. Additionally, you can only claim the amount of expenses that exceed two percent of your adjusted gross income.
Another deduction that can have a very big impact on your tax situation is the cost of health insurance premiums. If you pay a portion (or all) of the health insurance that may be offered by your employer, you can deduct this expense. As with unreimbursed job-related expenses, you will need to itemize deductions and may only claim medical expenses that exceed 10 percent of your adjusted gross income. There are other medical and dental expenses in addition to health insurance premiums that can also be deducted.
Job Loss Tax Implications
If you lose your job, there are also impacts to your tax liability. The first thing to keep in mind is that unemployment compensation may very likely be taxable as income. (Learn more about how the IRS defines unemployment compensation.) As taxable income, you will need to include any unemployment payments as gross income on your tax return. In the same way you would have an employer withhold taxes for you, you can also have taxes withheld on unemployment compensation. This is handled on Form W-4V, Voluntary Withholding Request. This is often a more convenient approach than making quarterly estimated tax payments. Withholding percentages are fixed at 7, 10, 15, or 25 percent.
You may also elect to tap some of the money in your traditional retirement account in the case of job loss. There is a 10 percent penalty for early withdrawal (before age 59½), but there are some exceptions. If you use an early distribution to cover the cost of medical insurance premiums for yourself, your spouse, or your dependents, you can quality for an exception from the penalty. There are other requirements tied to this exception (e.g. you must have received unemployment compensation for at least 12 weeks).
Regardless of any exception to the early withdrawal penalty, distributions from a traditional IRA or 401(K) are taxed as regular income. As with unemployment compensation, you should choose to have at least some of the taxes due withheld at the time of distribution.
There are also job-seeking expenses that you will be able to deduct when you file your tax return. To qualify, your job search must be in your current occupation, and you cannot deduct job-search expenses if there is a substantial time lapse between the end of your last job and your current search. These expenses include things like employment and outplacement agency fees; resume preparation, printing, and mailing; and travel expenses for job search or interview.
As with unreimbursed job expenses, your job-search expenses can only be deducted when you itemize and are subject to the same thresholds.
When you face a life transition that involves your career, be prepared for paperwork and the need to keep receipts and otherwise document your expenses in order to avoid overpaying taxes. It can be complicated, so feel free to contact us, and we can help you throughout the entire process.